Can litigation funding be considered a form of gambling, as a handful of US courts have ruled? Those in the industry argue not, rebuffing claims that they’re doing little more than peddling frivolous speculation.

Million-dollar rollover lotteries, legal bookmaking, card rooms and commercial casinos in Atlantic City, Las Vegas and various points in between. Gambling in the US is, it seems, everywhere you look – and some places you don’t.

But that he was betting with plaintiffs’ fortunes came as news to John ‘Sean’ Coffey, a former Latham & Watkins partner who co-founded New York third-party funder BlackRobe Capital in October 2011.

“Even in conversations with the most sceptical and challenging folks I’ve never heard them categorise what we’re doing as gambling,” Coffey confirms. “It’s a new argument to me, but it may be because the other lines of attack against litigation finance haven’t really gotten much traction.”

Once dubbed “Wall Street’s new nemesis” by Bloomberg for leading the prosecution in the USD 6 billion WorldCom securities litigation, Coffey is responding to a recent article by Anthony Sebok, a professor at Benjamin N Cardozo School of Law in New York, which looks at whether third-party funding can be considered a form of gambling.

Analysing a number of cases which raised the spectre of champerty and gambling, Sebok’s article – Betting on tort suits after the event: from champerty to insurance – finds that while states including Ohio and Alabama have ruled against funders, others, such as the North Carolina decision in Odel v Legal Buck, found that champerty was not, in fact, gambling.

And Sebok says the funding industry could escape the suggestion altogether if it were to present itself a “essentially a form of investment in the lawsuit of another.” He tells CDR that precisely such a move was effected during early days of the commodities and insurance markets, which were once attacked as being tantamount to a casino peddling sterile forms of speculation.

“The way it was ultimately sold to society was that the money goes into helping people invest in productive capacities, and not merely a way for people to take advantage of the vagaries of chance with statistical probabilities playing themselves out,” Sebok says.

“But this is nothing new; there has always been a pattern of taking the boundary line between investment and speculation and reframing it so it fits our desire to promote productive activities and not to encourage frivolous speculation.”

Sebok, who is widely recognised for his research into champerty, says there should be “no problem” reframing litigation finance in such a fashion, thereby jettisoning concerns over gambling and seeing them instead as a form of investment.

“But we still have to deal with the fact that critics of the industry consider it a form of anti-social investment,” he adds.

Gamble away

According to Selvyn Seidel, founder of US and UK third-party funder Fulbrook Management, the same critics are looking for a new bugbear now that questions over champerty’s legality are fading. (Legal in the UK, its permissibility varies from state to state in the US. Sebok notes that sixteen states permit the practice explicitly, with a further twelve permitting it implicitly.)

One needn’t worry overly about accusations of gambling, though, Seidel says. Instead, the question should be whether the industry is beneficial in practice – as an asset class capable of providing litigants with capital when needed, and on fair terms. That being the case, its name matters little.

“If this comes in the form of gambling, so what?” Seidel, a colleague of Coffey’s at Latham, where Seidel founded and chaired the firm’s international litigation and arbitration group and chaired the international practice group, contends. “If litigation funding serves civil justice, which it does, then even if you make a profit out of it, so what?”

Many forms of gambling are, lest we remember, legal in the US, including commercial casinos, legal bookmaking, card rooms and lotteries. “To gamble is not necessarily a ‘sin,’” Seidel, who co-founded and chaired Burford Capital before Fulbrook, says. “You can gamble your heart out and make a fortune,” he adds. “But the true question around third-party funding should be whether its benefits, such as serving civil justice, outweigh the potential problems such as frivolous lawsuits.”

But while Seidel, Coffey and Sebok are resolute in their belief that the industry is relatively well-protected against bad claims, there are others who believe precisely the opposite: the most vocal of which is the Institute for Legal Reform (ILR), a Washington, DC-headquartered offshoot of the US Chamber of Commerce.

Scevole de Cazotte, vice president of international initiatives at the ILR, is adamant that third-party funding increases frivolous litigation, and criticises Sebok for dismissing such concerns. (Sebok says William Blackstone’s fear that third-party investors would turn lawsuits into “engines of oppression” seems “far-fetched,” given that funders “operate under the same constraints as self-financing plaintiffs or lawyers who finance their clients’ suits under the system of the contingency fee.”)

A former regulatory attorney at WilmerHale, de Cazotte argues that unlike a lawyer operating under a contingency fee, who is bound by ethical rules, the litigation funder owes no duties to a potential claimant.

And unlike a contingency fee lawyer, who will decide whether to file a claim based – at least in part – on the strength of its legal merit, funders base their decisions on the present value of their expected return. Such a calculation is, he says, “a veritable recipe for frivolous litigation.”

He further argues that even if the claim has merit, the existence of funding can lead to non-merit-based outcomes.

“A claimant who must pay a third-party litigation funding company out of the proceeds of any recovery can be expected to reject what otherwise may be a fair settlement offer and hold out for a larger sum of money,” says de Cazotte, referring to the Ohio Supreme Court case of Rancman v Interim Settlement Funding, also cited by Sebok, which held that third-party litigation funding was an “absolute disincentive” to settlement.

“By the same token, the financing company can be expected to pressure claimants only to accept settlement offers that are sufficient to cover the amount financed after subtracting the claimant’s share of the recovery,” he adds.

Weird science

Sebok is well-aware of the ILR’s criticisms, and says that the group has developed two distinct –but, to his mind, contradictory – arguments against third-party funding.

First up is the so-called intermeddling argument, which chastises the funder for interfering with the litigation and altering the outcome of proceedings, whether for good or bad.

Such a contention cuts the heart of the champerty doctrine, and the 1904 case of British Cash and Parcel Conveyors v Lamson Store Service, in which Lord Justice Moulton defined champerty as being the “wanton and officious intermeddling with the disputes of others” with the “added notion of a division of the spoils.”

Sean Coffey nonetheless highlights the fact that insurers have long interfered in their clients’ disputes as being something of a lacuna in the century-old champerty prohibition. “Those companies have quite a lot to say to defendants about who they can hire as counsel, how much they can spend and whether they can settle the case,” Coffey explains. “So why is that okay but having someone finance your lawsuit is wrong?”

And Sebok calls the ILR’s second argument, concerning the immorality of betting on lawsuits, “just weird,” adding that the ILR is quick to roll it out to those audiences likely balk at self-indulgent forms of speculation.

“The two arguments are completely incompatible, but they can be made to different audiences at different times,” he says. “The gambling argument has reach where the investment one doesn’t, and vice versa. For example, read criticism of litigation finance in the business press or at seminars, where the audience is perfectly capable of recognising that the futures and options market was also perceived as a gambling vessel, it is the intermeddling argument that is used.”

Both the American Bar Association (ABA), whose 400,000 members make it the world’s largest professional voluntary organisation, and the New York City Bar Association, one of the country’s most influential, have given their blessing to Coffey, Seidel and the like – albeit with the caveat that lawyers “must approach transactions involving alternative litigation finance with care.”

For Coffey, however, such approval couldn’t come soon enough. He says the US litigation system all-too regularly sees large, capital-rich defendants deliberately prolong lawsuits, exhaust the resources of the plaintiff and force them into steeply discounted settlement.

And so, in the David versus Goliath battle that litigation often comes to represent, “funders put the stone in David’s sling,” Coffey explains, with the result that any resolution will be both quicker and more fair.

Sebok, who served as a report for the ABA’s working group, has the last word. “We need litigation funding,” he says. “And it’s not because I’m a great fan of being able to bet on outcomes, because I’m not, but so that its recipients’ chances of litigation are strengthened.”